Housing bailouts and false hopes

Government programs ostensibly designed to benefit homeowners were really intended to bail out the banks.

In April of 2008, I wrote a post about the psychology behind the various government programs designed to help banks kick the can until conditions got better. In the nine years that transpired since then, their efforts went from frantic, to desperate, to sublimely ridiculous. Each step along the way, the sheeple were strung along and enticed to make a few more mortgage payments in what will prove an ultimately futile effort to benefit from occupying a property they can’t afford.

Most of the stories written about this phenomenon were written by people on the political left who were lamenting the lack of progress in keeping loanowners in their debt prisons. Based on what many of these people wrote, they were actually convinced these programs were designed to help homeowners. That isn’t what these programs were for. These programs were always designed to bailout the banks. If a few homeowners benefited in some way, that was a bonus. The real reason these programs existed at all was to save the banks.

One of the more interesting phenomenon observed during the bubble was the perpetuation of denial with rumors of homeowner bailouts. Many homeowners held out hope that if they could just keep current on their mortgage long enough, the government would come to their rescue in the form of a mandated bailout program.

Part of this fantasy was not just that people could keep their homes, but that they could keep living their lifestyle as they did during the bubble. What few seemed to realize was any government bailout program would be designed to benefit the lenders by keeping borrowers in a perpetual state of indentured servitude. With all their money going toward debt service payments, little was going to be left over to live a life.

All of these plans had benefits and drawbacks. One of the first problems was to clearly define who should be “bailed out.” The thought of bailing out speculators was not palatable to anyone except perhaps the speculators themselves, but with regular families behaving like speculators, separating the wheat from the chaff was not an easy task.

If a family exaggerated their income to obtain more house than they could afford in hopes of capturing appreciation, did they deserve a bailout? The credit crisis that popped the Great Housing Bubble was one of solvency, and there was no way to effectively restructure payments when a borrower could not afford to pay the interest on the debt, and this was a very common circumstance.

None of the bailout programs did much for those with stated-income (liar) loans, negative amortization loans, and others who are unable to make the payments, and since this was a significant portion of the housing inventory, none of these plans had any real hope of stopping the fall of prices in the housing market.

The main problem with all of the plans is the moral hazard they created because those who did not participate in the bubble and behaved in a prudent manner would be penalized at the expense of those who were careless with risk. In one form or another either through free market impacts or direct subsidies from the government paid by tax dollars, these bailout plans all asked the cautious to support the reckless. The moral hazard involved and the moral outrage from those being asked to pay the bills prevented any of these plans from being implemented.

Many of the bailout plans called for changing the terms of the mortgage note. This might have been easy in the days when banks held mortgages in their own portfolios, but it was nearly impossible once these mortgages were bundled together in collateralized debt obligations and sold to parties all over the world.

Even if it would have been possible to easily change the terms, the resulting turmoil in the secondary mortgage market would have caused higher mortgage interest rates. When an investor faces the risk of the government changing the terms of their contract, and these changes would not be in their favor, the investor would demand higher returns. Higher investor returns means higher mortgage interest rates which would raise the cost of borrowing, the opposite of what the government bail plans were trying to accomplish.

Hope Now?

The first of the numerous bailout programs was “Hope Now” introduced in October of 2007. As the name suggests, Hope Now was sold to the general public as a reason for them to hang on and continue making crushing payments for as long as possible. It was a false hope, but even false hope gave homedebtors a little emotional relief, and it provided a few more payments to the lenders.

According to their website, “HOPE NOW is a cooperative effort between counselors, investors, and lenders to maximize outreach efforts to homeowners in distress.” The plan was to streamline the process of negotiating workouts between lenders and borrowers to keep borrowers making payments and ostensibly to stop them from losing their homes. The emphasis was on making payments and maximizing investor value in collateralized debt obligations.

Very few people benefited from the program, despite government claims to the contrary, and no rights or benefits were conferred to borrowers that they did not already contractually have. There was much fanfare when it was first announced, but the program did far too little to have any impact on the housing market.

The next bailout was aimed directly at the lenders with the Super SIV program introduced in November of 2007. An SIV is a special investment vehicle is an off-balance-sheet investment designed to hold investments a company (usually a lender) does not want to show on their own balance sheets. It is a smoke-and-mirrors device used primarily to get around regulations intended to stop lenders from taking excessive risk.

The Super SIV program was intended to purchase assets from the troubled SIVs and provide liquidity for lenders who desperately needed it. The problem with the Super SIV was simple: nobody wanted these assets. Moving bad mortgage paper around was akin to rearranging the deck chairs on the Titanic. Few in the general public knew what this program was for, and even fewer cared. Most wanted to know their government was doing something to solve the problem, and the Super SIV announcement provided them with much-wanted denial.

In December of 2007, the government offered a more direct homeowner bailout plan. The proposal was to freeze the interest rates on certain loans for certain borrowers for five years. This was greeted as a panacea by all parties, and the beast of homeowner denial was fed once again. As with the Hope Now program, few people qualified, and it did nothing to hold back the tide of increasing defaults and foreclosures. The denial was short lived, and this unnamed bailout plan quickly fell from the headlines.

In the Savings and Loan disaster of the late 1980s, the government was liable to investors for their losses through the Federal Savings and Loan Insurance Corporation (FSLIC.) The government had no choice by to compel taxpayers to cover the costs of the industry bailout. The Great Housing Bubble had no such government liability.

However, in February of 2008 Congress and the President signed the Economic Stimulus Act of 2008 temporarily increasing the conforming loan limit for Fannie Mae and Freddie Mac, the government sponsored entities (GSEs) that maintain the secondary mortgage market. This had the ominous prospect of putting the government in a position where they may step in with taxpayer money to bail out the GSEs, even though the GSEs are explicitly not backed by the assurance of government assistance.

The GSEs provide insurance to mortgage backed securities, and by raising the conforming limit, the GSEs were able to insure large, so called “jumbo” loans. This enabled the holders of jumbo loans who were unable to sell these mortgages access to capital in the secondary market. The secondary mortgage market behaves as if the GSEs are government backed, and if they were to fail due to losses from the insurance they provide, the government may have had to step in to back them. All of this was seen as another reason for homeowners in severely inflated bubble markets to hope the government was going to rescue the housing market.

Forgiveness of Debt

Perhaps the most outrageous suggestion put forth was the suggestion by the FED Chairman Ben Bernanke when he proposed lenders forgive mortgage debt in early 2008. The moral hazards were obvious. Would people stop making their payments to make sure they qualified? Would more people buy homes they could not afford then appeal for debt relief?

Rational people became frightened when they heard the head banker in the United States propose massive debt forgiveness as they realized this meant the entire banking system was in peril. The implications of this proposal were lost on the typical homedebtor who only saw how they might benefit from it.

Debt forgiveness was the ultimate fantasy of every homedebtor. They could be relieved of their financial burdens and get to keep their houses and their lifestyles. It did not matter to the financially troubled that the proposal made no sense and had no possibility of happening, the thought of it would motivate them to hang on a little longer to see if maybe they could hit the jackpot.

Do Nothing

It is difficult not to become cynical about all the various bailout programs, and the proposals outlined were not the only ones discussed in the public forum. There was a steady drumbeat of public plans and announcements that were never substantial, and their only purpose seemed to be to foster denial among those who needed it.

At the time of this writing, no substantive bailout program has been implemented, and that is a good thing. There is no possible bailout program without the commensurate moral hazards and unfair benefits they would contain. The best course of action would be to ease the transition of people from overextended homeowner to renter and not to attempt to manipulate the financial markets for the benefit of a few. There is nothing that can be done to prevent of the collapse of a financial bubble. The solution lies in easing the pain of their deflation and in preventing them from inflating in the future.

2017 Perspective

We have added history to the perspective above, but nothing really has changed. The list of bailout programs grew significantly, and each one was as big a failure as the last. In 2012, the banks finally achieved their threshold of success as the false hope bailout programs finally got enough borrowers into loan modification programs to dry up the foreclosures and MLS inventory. A 50% reduction in inventory caused prices to bottom and move up dramatically in certain markets.

In the end, there are still millions of people clinging to properties they can’t afford. Perhaps some will survive through a loan modification and remain current on their mortgages through to an equity sale at a time of their own choosing. Many will sell and leave their properties with little or nothing to show for their 10+ years of homeownership holding title. I wonder how many of them felt that the bailout was a good thing after all?

8 responses to “Housing bailouts and false hopes”

Home prices continued their five-year run of increases in March, up 7.5 percent from last year to a national median sale price of $273,000. Sales growth was also strong, up 8.9 percent, even as the number of homes for sale fell for the 18th consecutive month, down 13 percent Y-O-Y. The typical home went under contract in 49 days, making it the fastest March for home selling on record since Redfin began tracking this data in 2010.

Rents across the country rose 0.7% from last March, the slowest rate of appreciation since November 2012, as new construction began to meet renter demand and soften the market. The median rent payment in the U.S. is now $1,408, according to the March Zillow® Real Estate Market Reports.

Rents in the Bay Area have slowed more than any other large metropolitan area over the past year. In San Francisco, rents are down 0.1% after appreciating almost 10% annually at this time last year. Rents in San Jose were rising at almost 9% annually a year ago, but fell 1.1% over the past year to a median rent payment of $3,451.

Even in hot West Coast markets, where rental growth is notoriously strong, rent appreciation is starting to slow. In Seattle, rents are up 6.7%, but their pace of appreciation has been slowing since August 2016. Rents in Sacramento are up 4.7%, but were rising at almost 7% annually toward the end of last year.

“The slowdown in rental appreciating is mainly due to new construction finally meeting demand, and even outpacing demand in some areas,” said Zillow’s Chief Economist Dr. Svenja Gudell. “But, rents are the highest they’ve ever been, weighing heavily on renters’ budgets and making it extremely difficult for those renters hoping to become homeowners to save enough money for a down payment. In most markets, a monthly mortgage payment is more affordable than a monthly rent payment, but the most difficult aspect of home buying for many aspiring home owners is coming up with enough money for the down payment.”

On a predictably gorgeous South Florida afternoon, Coral Gables Mayor Jim Cason sat in his office overlooking the white-linen restaurants of this affluent seaside community and wondered when climate change would bring it all to an end. He figured it would involve a boat.

When Cason first started worrying about sea-level rise, he asked his staff to count not just how much coastline the city had (47 miles) or value of the property along that coast ($3.5 billion). He also told them to find out how many boats dock inland from the bridges that span the city’s canals (302). What matters, he guessed, will be the first time a mast fails to clear the bottom of one of those bridges because the water level had risen too far.

“These boats are going to be the canary in the mine,” said Cason, who became mayor in 2011 after retiring from the U.S. foreign service. “When the boats can’t go out, the property values go down.”

He worries that rising insurance costs, reluctant lenders or skittish foreign buyers could hurt home prices well before sea-level rise gets worse.

If property values start to fall, Cason said, banks could stop writing 30-year mortgages for coastal homes, shrinking the pool of able buyers and sending prices lower still. Those properties make up a quarter of the city’s tax base; if that revenue fell, the city would struggle to provide the services that make it such a desirable place to live, causing more sales and another drop in revenue.

And all of that could happen before the rising sea consumes a single home.

President Donald Trump’s plan to review the H1-B visa program has Silicon Valley gravely concerned. At Facebook, more than 15% of its employees hold such visas. These large tech companies rely on this program to hire talented work overseas when qualified Americans are unavailable.

However, as Elaine Ou points out in an op-ed for Bloomberg, it’s not that qualified Americans don’t exist. It’s that they can’t afford to live in Silicon Valley. These large tech companies skew heavily toward young workforces, roughly 30 years of age, compared to the national average workforce age of 42 years old. A large part of that is because only younger employees without families can afford or withstand the lifestyle these companies require in locations like Mountain View and San Francisco – and 75% of H1-B visa holders are under 35 years old.

For whatever inexplicable reason, big technology companies insist on building their offices in areas with tight zoning restrictions. Mountain View, hometown to Alphabet Inc.’s Google, gained 17,921 jobs between 2012 and 2015, but added only 779 units of housing over the same period. San Francisco added a bit more than 9,000 housing units while gaining half a million jobs. Given the scarcity of housing, many new incoming residents have to outbid a current resident to move in. Palo Alto’s city planning commissioner recently resigned because she and her husband could not afford to raise a family in Palo Alto — even though both had jobs at leading tech companies.

This is bull. I work in the tech industry and I can tell you that the reason the workforce skews younger has nothing to do with housing costs. That’s ludicrous on the face of it because the workforce has skewed young here since the 1960s when housing was relatively cheap.

The workforce skews young because younger people cost less and are more willing to work crazy hours, which makes their hourly rate cheaper still. People outside the industry don’t know this, but inside the industry everyone (in management at least) knows the business model requires lots of free overtime. Otherwise the work cannot be done. This is also the main driver for hiring H1-B holders. They tend to worker cheaper and for more hours. It is as simple as that. Anyone telling you the tech companies can’t find enough qualified candidates is lying. The fact is they can’t find qualified candidates to work at the rates they want to pay them.

I am the hiring manager on a new requisition and in three weeks we’ve already have over 70 applicants, of whom 15 or 20 are pretty good (I manage an integrated circuit design group). Can’t find qualified candidates? Give me a break.

And what Mountain View is doing right now is criminal. Anyone living in the Bay Area has watched the high-rises going up along highway 237 on land that used to be used by NASA Ames and Lockhead and… they are all commercial buildings, no apartments at all. Talk about tragedy of the commons.

Foreign money has been a key ingredient in propping up home values in many cities across the United States. There is no doubt about this. If you look at places like Irvine, many new home communities are being sold largely to investors from China. This also applies to house mania happy San Francisco. Yet even if you question your own sanity regarding California crap shack prices, things may look affordable to certain people abroad. The amount of investment flowing in from China into the United States is amazing. A large part flows into real estate. This is how you get lower homeownership rates and also a drop in mortgage application volume yet somehow, you see home prices surging on low inventory. In a global market money can flow in and out of systems easily.

The Chinese Connection

There is a global compression of the middle class and this is impacting people in all corners of the market. While San Francisco and Los Angeles home prices seem wild, just look at prices of real estate in some cities in China: